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The Italian Miracle

April 29, 2013 8:27 amApril 29, 2013 8:27 am

Italy is a mess. Yes, it has a prime minster, finally; but the chances of serious economic reform are minimal, the willingness to persist in ever-harsher austerity — which the Rehns of this world tell us is essential
— is evaporating. It’s all bad. But a funny thing is happening:

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What’s going on here? I think that we’re seeing strong evidence for the De Grauwe view that soaring rates in the
European periphery had relatively little to do with solvency concerns, and were instead a case of market panic made possible by the fact that countries that joined the euro no longer had a lender of last resort,
and were subject to potential liquidity crises.

What’s happened now is that the ECB sounds increasingly willing to act as the necessary lender, and that in general the softening of austerity rhetoric makes it seem less likely that Italy will be forced into
default by sheer shortage of cash. Hence, falling yields and much-reduced pressure.

It also, to be a bit self-justifying, shows that back when I used to cite Italy in the 1990s as an example of how advanced countries can carry high debt loads, I wasn’t being naive. Back then Italy had its own
currency, and debt denominated in that currency; yes, it was pegged to the Deutsche Mark, but there was always the option of unpegging. By joining the euro, Italy in effect turned itself, macroeconomically, into
a third-world country with debts in someone else’s currency, and exposed itself to debt crisis; now, thanks to the Draghi put, it has stepped half way back into the first world.